Social Security: Closing the Gap

Social Security isn’t about to go bust anytime soon—it will be able to pay full benefits through 2037. But after that, if no changes are made, the system would only take in enough in payroll taxes to pay about 75 percent of benefits through 2083.

The Congressional Budget Office estimates the shortfall to be about 0.6 percent of gross domestic product over the next 75 years.

“Social Security is not in crisis,” says John Rother, executive vice president of policy and strategy for AARP. “That’s a small number relative to the economy. It’s a challenge, but it is not that hard.”

In July, a CBO report analyzed 30 different policy options that could help provide long-term financial stability for Social Security or improve the adequacy of benefits. The report is significant because Congress relies on CBO cost estimates when it passes legislation.

None of the options would reduce the initial benefits of people older than 55.

Here’s a look at some of the key proposals in the CBO report.

1. Change the tax structure.

Social Security is paid for by a 12.4 percent payroll tax, split equally between workers and their employers. Gradually raising the payroll tax by 2 percentage points to 14.4 percent over the next 20 years would completely eliminate the shortfall. But future workers would be burdened with significantly higher taxes.

Congress could eliminate the shortfall by deciding to maintain the current tax rate but eliminating the salary cap that’s now at $106,800. The cap, which increases as average earnings rise, is expected to reach about $113,700 by 2012. Or it could raise the cap even farther; setting it at $156,000 per year would tax about 90 percent of the country’s earnings, and close about a third of the 75-year shortfall.

2. Reduce initial benefits payments.

There are many ways to cut the initial retirement benefit—the amount of the first Social Security payment. For example, cutting the initial benefit by a set percentage across the board—this would have a disproportionate impact on low-income workers because they depend on Social Security more.

Other options are raising the number of work years (from 35 to 38) that go into calculating an individual Social Security benefit, or indexing benefits to longevity; as life expectancies rose, initial benefits would fall.

One idea receiving a lot of attention is to use “price indexing” rather than the current system of “wage indexing” when calculating initial Social Security benefits. Because prices tend to rise 1 percentage point a year less than wages do, this would, all by itself, save more than enough to do away with the shortfall—and also substantially cut initial benefits over the long run.

Using a price-based index would cut initial benefits for workers by 2060 by 48 percent compared with today’s levels.

Congress could also consider limiting benefits for top earners. But depending on how low the dividing line was set, this change could hit very average, very middle-income workers, says Dean Baker, codirector of the Center for Economic and Policy Research in Washington.

Cutting initial benefits for the top 70 percent of earners would close almost all of the shortfall, but it would hit all but the bottom tier of workers.